Top investment lessons from 2016

Posted 27 November, 2016


Challenging year shows the benefits of patient, long-term approach.

Volatility has led the sharemarket in 2016. Over the year market confidence was thin, from the US Federal Reserve’s plans to lift interest rates and calls that the global bond market may be nearing the end of a 35-year bull run.

In Australia, uncertainty was heightened by cuts to interest rates, and constant headlines about a potential property bubble and how first-home buyers may be priced out of the market. Speculation around policy moves for superannuation and popular investment strategies like negative gearing, gave investors further reasons to be skittish, keeping markets on a tightrope.

Although good investments were hard to come by, that does not mean they were not there. But investors had to look beyond the hype and headlines to find them.

Here are some key investment lessons so far from 2016:

Property – there’s more than residential addresses
Australians’ love of owning residential real estate continued to drive the economy, and Sydney and Melbourne home prices in particular continued their strong growth. The market noise about the “never-ending boom’ of residential property made it important not to get caught up in the hype and look for quality assets in already mature markets.

The focus on residential saw commercial property overlooked, with its yields well above the residential sector and attractive margins above cash rates. Some good buying opportunities may remain, but only where due diligence stacks up.

Two of the most popular ways to access this asset class are through Australian Real Estate Investment Trusts (AREITs) listed on ASX, such as Scentre Group (SCG), or by direct investment. AREITs generally offer good liquidity and are available to investors with moderate sums of money. But they can be volatile, as seen during the GFC, and it is vital to consider the funding structures to know how much leverage is used behind the scenes.

Direct investments offer less liquidity but can be more stable by not being affected by day-to-day sharemarket fluctuations. With commercial property prices typically in the millions of dollars, only a few investors can afford to go directly to the vendor, but investors may still be able to access this asset class via specialist funds that pool investors together to buy properties.

Small-caps disrupt big end of town
This year, for the first time in four years, Australian small-cap shares have outperformed the S&P/ASX 200 Index. To the end of September the ASX 200 was up 6 per cent, including dividends, while the Small Ords Index was up 16 per cent.

This run sees some small-caps closing the year with quite high valuations, making opportunities harder to find and emphasising the warnings for investors picking next year’s stocks based on this year’s winners.

Asia’s growth story continues
While other regions in the world saw relatively slow growth, Asia continued to perform well (with the notable exception of Japan) and be a provider of global growth. Asia and emerging economies are trading on historically cheap valuations compared to their more expensive developed-market counterparts.

Although it is easier than ever for investors to access global markets through exchange-traded funds (ETFs), they must dig beyond the headlines and be selective with the investments and fund managers they choose. ETFs take everything – the good, the bad and the ugly.

Active funds that provide exposure to the region and can be bought on ASX include Platinum Asia Investments Limited (PAI), Asian Masters Fund Limited (AUF) and Emerging Markets Masters Fund (EMF). Although they charge a higher fee compared to an index or passive fund, an active manager on the ground can monitor companies by physically going to the premises, and having local knowledge about the company can give investors an edge.

Brexit – a reminder of the global nature of investing
In the global financial markets you can’t be totally isolated and Brexit (Britain’s planned exit from the European Union) was the textbook definition of why geopolitical risks cannot be ignored. The Australian sharemarket fell sharply after initial referendum results were announced, despite having limited direct impact on Australia.

The ASX rebounded over the following weeks but we are yet to see how the decision will play out in the long term. Events such as this are difficult to avoid but broad diversification across regions and asset classes can help.

Gold – investing in alternatives in a low interest environment
Low interest rates drove greater demand for alternatives – especially where they could help protect against market volatility through diversification and act as a hedge against potential inflation. Historically, gold has provided this insurance.

Individuals with a higher proportion of risk assets in their portfolio – including a high weighting to equities – may have benefited from considering this asset. Direct exposure to physical gold rather than to gold-producing companies allows investors to avoid taking on operational risk. Physical gold can be bought through ETFs listed on ASX.

Bonds may not be as safe as they once were
With many analysts questioning if the 35-year bull market for bonds may be about to lose its puff, investors took stock of their exposure to this asset class. Bond prices are typically negatively correlated to interest rates and have benefited as rates around the world have approached record lows.

The continued buildup around potential increases in US interest rates has created significant volatility for bond investors. If the US does raise rates significantly, bonds will be in for a tough time, with income received not sufficient to cushion potential capital losses.

Cash – as the saying goes, ‘cash is king’
Last year we talked about the importance of maintaining cash within investment portfolios. Unfortunately, 12 months on and interest rates are even lower, making it even harder to resist the temptation to buy risky assets to generate income. Keeping a good cash reserve remains important and at times has allowed attentive investors to take advantage of good buying opportunities during market dips.

In summary
These lessons from 2016 can be wrapped up in three core themes for investors:

  1. Always look beyond the hype and headlines and do deep due diligence.
  2. Take a broad holistic view to decision-making and in planning your portfolio. This means looking forwards, backwards and checking your blind spots.
  3. Even if you are just investing in Australia, you have to think globally.

All the best for a year of successful and prosperous investing in 2017.